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February 15, 2009

Unrelated Business Taxable Income (UBTI)

Your Guide

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Definition

The gross income derived from any unrelated trade or business regularly carried on by the exempt organization, less the deductions directly connected with carrying on the trade or business. If an organization regularly carries on two or more unrelated business activities, its unrelated business taxable income is the total of gross income from all such activities less the total allowable deductions attributable to all the activities.

In computing unrelated business taxable income (UBTI), gross income and deductions are subject to certain modifications and special rules. Whether a particular item of income or expense falls within any of these modifications or special rules must be determined by all the facts and circumstances in each specific case. For example, if the organization received a payment termed rent that is in fact a return of profits by a person operating the property for the benefit of the organization, or that is a share of the profits retained by the organization as a partner or joint venturer, the payment is not within the income exclusion for rents.

Unrelated business income (UBI): If an IRA, qualified plan account, 403(b) or 457(b) receives unrelated business income (UBI) of $1,000 or more, the UBI is subject to UBI-Tax ( UBIT). UBI is the income from a trade or business that is regularly carried on by an exempt organization and that is not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity.

  • Trade or business:  The term “trade or business” generally includes any activity carried on for production of income from selling goods or performing services. An activity does not lose its identity as a trade or business merely because it is carried on within a larger group of similar activities that may, or may not, be related to the exempt purposes of the organization.   For example, the regular sale of pharmaceutical supplies to the general public by a hospital pharmacy does not lose its identity as a trade or business, even though the pharmacy also furnishes supplies to the hospital and patients of the hospital in accordance with its exempt purpose. Similarly, soliciting, selling, and publishing commercial advertising is a trade or business even though the advertising is published in an exempt organization’s periodical that contains editorial matter related to the organization’s exempt purpose.
  • Regularly carried on:   Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations.    For example, a hospital auxiliary’s operation of a sandwich stand for 2 weeks at a state fair would not be the regular conduct of a trade or business. The stand would not compete with similar facilities that a nonexempt organization would ordinarily operate year-round. However, operating a commercial parking lot every Saturday, year-round, would be the regular conduct of a trade or business.
  • Not substantially related:    A business activity is not substantially related to an organization’s exempt purpose if it does not contribute importantly to accomplishing that purpose (other than through the production of funds). Whether an activity contributes importantly depends in each case on the facts involved.   In determining whether activities contribute importantly to the accomplishment of an exempt purpose, the size and extent of the activities involved must be considered in relation to the nature and extent of the exempt function that they intend to serve. For example, to the extent an activity is conducted on a scale larger than is reasonably necessary to perform an exempt purpose, it does not contribute importantly to the accomplishment of the exempt purpose. The part of the activity that is more than needed to accomplish the exempt purpose is an unrelated trade or business

Referring Cite

IRC§ 512, IRC§ 513, IRS Publication 598

Additional Helpful Information

  • The IRS defines UBI as an unrelated business (and subject to unrelated business income tax) if it meets three requirements:
    • It is a trade or business,
    • It is regularly carried on, and
    • It is not substantially related to furthering the exempt purpose of the IRA.

There are, however, a number of modifications, exclusions, and exceptions to the general definition of unrelated business income.

  • Generally, UBI is taxable, but there are exclusions and special rules that must be considered when figuring the income.

    • Exclusions : The following types of income (and deductions directly connected with the income) are generally excluded when figuring unrelated business taxable income ( exceptions to each category may apply)
    • Dividends, interest, annuities and other investment income
    • Income from lending securities( if the loan is made under certain specific agreements)
    • Royalties,  including overriding royalties
    • Rent from mixed leases,  if the rents attributable to the personal property are not more than 10% of the total rents under the lease, as determined when the personal property is first placed in service by the lessee.
    • Income from research
    • Gains and losses from disposition of property
    • Gain or loss on disposition of certain brownfield property
    • Member income of mutual or cooperative electric companies
    • Dues of Agricultural Organizations and Business Leagues
  • To qualify as allowable deductions in computing unrelated business taxable income, the expenses, depreciation, and similar items generally must be allowable income tax deductions that are directly connected with carrying on an unrelated trade or business. They cannot be directly connected with excluded income.
  • To be directly connected with the conduct of an unrelated business, deductions must have a proximate and primary relationship to carrying on that business
  • Certain trade or business activities are not treated as an unrelated trade or business. These include the following (exceptions may apply to each category) :
    • Volunteer workforce
    • Convenience of members
    • Qualified sponsorship activities
    • Selling donated merchandise   
    • Employee association sales
    • Bingo games
    • Gambling activities other than bingo
    • Pole rentals
    • Distribution of low cost articles
    • Exchange or rental of member lists
    • Hospital services
    • Public entertainment activity
    • Convention or trade show activity

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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